Desiring a tax benefit is not enough for Part IVA to apply: Minerva Appeal

In a unanimous decision, the Full Federal Court has overturned a decision of a single judge of the Federal Court in Minerva Financial Group Pty Ltd v Commissioner of Taxation [2022] FCA 1092 (Minerva). In that case, the Federal Court had upheld a decision of the Commissioner of Taxation (Commissioner) to apply the general anti-avoidance rule, Part IVA, to arrangements that included not exercising a discretion to distribute more than nominal amounts of income to holders of “special units” in a trust. However, on appeal the Full Court found that the trustee had exercised its discretion to distribute income in accordance with the trust constitution and the terms on which the units were issued. There was nothing in the surrounding circumstances that objectively supported the conclusion that the arrangements were entered into for the dominant purpose of obtaining a tax benefit.

The Full Court decision confirms the approach to be taken in relation to ascertaining the purpose of a party for the purposes of section 177D of the Income Tax Assessment Act 1936:

“Purpose directs attention to object or aim. It is concerned with the reason why something has occurred or been allowed to occur. The objective dominant purpose of a party to a scheme (such as an action or course of action) that has enabled a person to obtain a tax benefit is determined by regard to what has happened and evaluating why it happened. Obtaining the tax benefit is not enough. Desiring the tax benefit is not enough. The obtaining of the tax benefit must have been the main object or aim of what is said to be the scheme when viewed objectively in its surrounding context.”

The Full Court (Justices Besanko, Colvin and Hespe) handed down its decision in Minerva Financial Group Pty Ltd v Commissioner of Taxation [2024] FCAFC 28 on 8 March 2024 (Minerva Appeal).

In Minerva, the Commissioner attempted to apply Part IVA to three putative schemes:

• The first scheme, being the creation of two “silos” within the Liberty Financial group’s corporate group structure for holding the group’s assets (a Corporate Silo and a Trust Silo) and steps taken so that income from investments in securitisation trusts (held by the Minerva Holding Trust (MHT)) were distributed to the Trust Silo.
• The second and third schemes, the ‘true gist’ of which were said to be the decision by the trustee of the MHT in the Trust Silo to only distribute nominal amounts of income to the Corporate Silo (via “special units”) such that almost all of the income was distributed through the Trust Silo.

The relevant tax benefit obtained under each of the schemes was that the profits distributed through the Trust Silo were subject to withholding tax at 10 per cent rather than 30 per cent had the income been distributed to Liberty Financial Pty Ltd (LF) and derived within the Corporate Silo.

The decision at first instance

Our observations on the decision at first instance are set out in our article on Minerva.

In summary, the primary judge held that Part IVA did not apply to the first scheme, being the restructure of the Liberty Financial group into the Corporate Silo and Trust Silo and that the Commissioner’s alternate postulate that the restructure would not have occurred was unreasonable. However, the primary judge then proceeded to find that the second and third schemes had been entered into with the dominant purpose of obtaining a tax benefit. In reaching this conclusion, significant emphasis was placed on the taxpayer being “unable to provide any cogent reason, other than the tax benefit, why the decision was taken in each of the relevant years to direct no more than 2% of MHT’s net income to the special unitholders.”

Minerva Appeal

Before considering the substance of the arguments, the Full Court helpfully summarises the relevant principles which apply to the operation of Part IVA, including that:

• Part IVA requires an objective determination of purpose of a person who entered into or carried out the scheme, by reference to the statutory factors set out in section 177D of the Income Tax Assessment Act 1936 (section 177D factors);
• Part IVA does not require or permit an enquiry into the subjective motives of the taxpayer or any other participants to the scheme;
• the test for establishing dominant purpose is not a “but for” test and not a question of causation;
• merely because a taxpayer chooses between two forms of transaction based on tax considerations does not mean, having regard to the section 177D factors, that a taxpayer entered into the scheme with the requisite dominant purpose; and
• Part IVA does not require that a taxpayer choose a form of transaction which results in the most tax or more tax being payable.

Having restated the applicable principles, the Full Court noted that the “difficulty” with the reasoning of the primary judge was the conclusion that the taxpayer’s inability to proffer a cogent reason (other than the tax benefit) for its income distribution decisions meant that the first and third of the section 177D factors (i.e. manner and timing of the schemes) were indicative of the second and third scheme being entered into for the dominant purpose of obtaining a tax benefit. By approaching the question of dominant purpose in this way, the primary judge’s reasoning “elides the question posited by s 177D with an inquiry as to whether the trustee’s discretion would have been exercised differently but for the tax benefit”. The Full Court also reiterated that because purpose is to be objectively determined, evidence of subjective understanding of commercial reasons or motives do not answer the question posited by section 177D.

The Commissioner on appeal had sought to argue that the Liberty Financial group’s conduct before the group’s restructure into the Corporate Silo and Trust Silo supported the conclusion that the second and third schemes were entered into with the dominant purpose of obtaining a tax benefit. The Commissioner used the pre-reorganisation characteristics as the lens through which the objective purpose of subsequent conduct in the relevant years was to be understood. The Full Court noted that, in effect, the Commissioner’s case assumed there was no objective reason for distributing income in the way it was other than a desire to secure a tax advantage.

However, the Full Court was of the view that the Commissioner’s case suffered from two “fundamental difficulties”. Firstly, the Commissioner’s argument that the reorganisation of the group into the Corporate Silo and Trust Silo was a scheme was rejected at first instance and the Commissioner did not challenge this on appeal. Second, over the relevant period, the business of the group had, as a matter of fact, grown significantly. Its sources of funding had changed. This meant that it was not possible to use the characteristics of the group’s business prior to its restructure as a basis to objectively draw conclusions on why things were done in the relevant (post restructure) years in a certain way.

Having accepted that the Corporate Silo and Trust Silo were established as part of a legitimate restructure, the question became whether the particular way in which the distributions were made within that structure attracted the operation of Part IVA. After considering each section 177D factor, the Full Court ultimately found that all the trustee of the MHT did was make distributions of income in accordance with the constitution of the MHT and the terms on which the units were issued (where the terms of units had their “expected features”) and that the distributions carried real benefits to those unitholders. Objectively, this does not point to the existence of a dominant purpose to obtain a tax benefit.

In considering the first section 177D factor (the manner in which the scheme was entered into or carried out), the Full Court held:

"Objectively there was nothing extraordinary about distributions flowing in accordance with the terms of the trust constitution. The terms of issue of the units were the “expected features” of the units. A payment of distributions in accordance with their terms of issue is not an objective matter that points to a party carrying out the scheme for dominant purpose of enabling the taxpayer to obtain a tax benefit."  [Emphasis added]

In relation to the third section 177D factor (timing of the scheme), the Full Court concluded that the timing of the resolutions to exercise (or not exercise) the income distribution discretion “tells one nothing about the dominant purpose of a party” to the scheme.

The Full Court also disagreed with the primary judge’s reasoning on the fifth and sixth section 177D factors (being the change in financial position of the taxpayer or a connected person) finding that the Commissioner discounted the financial consequences to the ultimate parents of the Liberty Financial group of the income distributions made to them via the Trust Silo and failed to recognise that the Liberty Financial group’s business was growing and additional debt and equity were raised to support the growing business.

Implications

This decision is a significant win for taxpayers, arriving in the context of heightened examination by the ATO of trust structures and choices made by taxpayers to arrange their affairs.

The key lessons from this case include:

• Part IVA involves a careful weighing of all relevant circumstances, supported by evidence, as against the section 177D factors. It is not appropriate to conduct the analysis of the factors in a selective manner or from the perspective of historical reasons without regard to the actual circumstances in the relevant years;
• The taxpayer had put on a considerable amount of evidence to facilitate findings to be made in relation to the application of the section 177D factors. This evidence was critical in providing the Full Court comfort to dismiss the Commissioner’s contentions;
• Caution should be taken in equating the existence of a subjective “commercial rationale” or “bona fide commercial reasons” with a scheme to which Part IVA does not apply. The task required by the legislation requires particular regard to the section 177D factors. The assessment of purpose required is objective. Subjective evidence does not determine the answer to the question posed by section 177D; and
• The application of Part IVA to choices available to taxpayers has been a longstanding contentious issue. Importantly, in this case the primary judge had found that the restructure, which resulted in the creation of the separate Corporate Silo and Trust Silo was not a scheme to which Part IVA applied. Additionally, the Commissioner’s case on appeal did not (at least in the Full Court’s view) adequately address why it was appropriate for the Court to draw objective conclusions about the taxpayer’s conduct based on the group’s pre-reorganisation characteristics. In this context, the application of the section 177D factors objectively point away from a dominant purpose of obtaining a tax benefit. This suggests that, in the absence of other surrounding circumstances, the mere exercise of a pre-existing trustee discretion in accordance with its terms should not attract the operation of Part IVA, even if the discretion is exercised in a way that results in a tax benefit.

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